Chapter 4
Job Order Costing
Job Costing vs. Process Costing
Procedure of Job Costing
Actual vs. normal Costs
1
Building Block Concepts of Costing Systems
The following five terms constitute the building blocks
that will be used in this chapter:
1
2
3
4.
5
A cost object is anything for which a separate
measurement of costs is desired.
Direct costs of a cost object are costs that are related
to the particular cost object and can be traced to it
in an economically feasible way.
Indirect costs of a cost object are costs that are
related to the particular cost object but cannot be
traced to it in an economically feasible way.
Cost pool is a grouping of individual cost items.
Cost allocation base is a factor that is the common
denominator for systematically linking an indirect
cost or group of indirect costs to a cost object.
2
Cost Pools
Accounting subdivides costs in different categories
according to traceability
Assume we intend to trace factors to products. Then we
form a separate cost pool for the costs traceable to each
product.
• Costs that may be traced to a product go to the respective
pool.
Costs that cannot be traced to an individual product are
recorded in an overhead cost pool.
• Should there be costs that cannot be traced to a single
product but to a group of products, we may form a cost pool
for the group of products.
The attempt to trace costs to products serves the
desire to know something about product profitability.
3
Types of Cost Pools
Product cost pool: collects costs that are associated
to any set of products.
Direct Product Cost Pool: a product cost pool that is
associated with a single product
• i.e. direct costs are traceable to a single product
Indirect Product Cost Pool: collects product costs that are
not directly traceable to individual products but allocated to
them according to an allocation base determined as part of
the accounting system
Expenses that are neither traceable nor allocated to
products are associated with the time period
Matching Principle: Product costs are expensed in
the period in which the revenue is realized, periodrelated expenses are charged against the income of
the period.
4
Generalization: Cost Objects and Activities
Not only products for sale can be cost objects.
Also a customer,
a product category,
a period,
a project (R&D or reorganization),
an activity or
a department
may qualify as a cost object and, consequently, have
a separate cost pool.
5
Cost Pools and Cost Objects
Cost Pools
Assignment
direct cost of A
Cost objects
A
Tracing
direct cost of B
indirect costs
B
If B is an activity
used exclusively
by O then its cost
can also be traced to
O
Allocation
O
6
Job-Costing and Process-Costing Systems
There are two basic systems used to
assign costs to products or services:
1 Job costing
In a job-costing system, the cost object is an
individual unit, batch, or lot of a distinct
product or service called a job.
2
Process costing
In process costing, the cost object is masses of
identical or similar units of a product or
service.
Process costing allocates costs among all the
products manufactured during that period.
7
1. General Approach to Job Costing
The following seven-steps approach is used to
assign actual costs to individual jobs:
1
2
3
4
5
6
7
Identify the chosen cost object(s).
Identify the direct costs of the job.
Select the cost-allocation base(s).
Identify the indirect costs associated with each
cost-allocation base
Compute the rate per unit of each cost-allocation
base used to allocate indirect costs to the job.
Compute the indirect costs allocated to the job.
Compute the cost of the job by adding all direct
and indirect costs assigned to it.
8
Example
Swing&Squeak (Sw&Sq) Limited manufactures
various sporting goods.
Sw&Sq is planning to sell a batch of 25 special
machines (Job 100) to Sweat & Groan Gym for
$104,800.
The 7 steps:
Step 1: The cost object is Job 100.
Step 2: Identify the direct costs of Job 100.
• Direct material = $45,000
• Direct manufacturing labor = $14,000
Step 3: Select the cost-allocation base.
• S&S chose machines hours as the only allocation base for linking all indirect
manufacturing costs to jobs.
Job 100 used 500 machine hours.
2,480 machine hours were used by all jobs.
Step 4: Identify the indirect costs.
Actual manufacturing overhead costs were $65,100.
p.t.o.
9
Direct materials
Direct labor
Factory overhead
Total
$45,000
14,000
13,125
$72,125
Step 5: Compute the rate per unit.
Actual indirect cost rate is $65,100 ÷ 2,480 = $26.25 per
machine hour.
Step 6: Compute the indirect costs allocated to the job.
$26.25 per machine hour × 500 hours = $13,125
Step 7: Compute the cost of Job
10
Actual Costing and Normal Costing
Actual Costing is a job-costing system that uses
actual costs to determine the cost of individual jobs.
Actual costing is a method of job costing that traces direct
costs to a cost object by the actual direct-cost rate(s) times
the actual quantity of the direct cost input(s)
and allocates indirect costs using indirect costs to a cost
object by using the actual indirect-cost rate(s) times the
actual quantity of the cost allocation base.
Normal Costing allocates indirect costs based on the
budgeted indirect-cost rate(s) times the actual
quantity of the cost allocation base(s).
11
Normal Costing
Assume that S&S budgets $60,000 for total
manufacturing overhead costs and 2,400 machine
hours.
What is the budgeted indirect-cost rate?
$60,000 ÷ 2,400 = $25 per hour
How much indirect cost was allocated to Job 100?
500 machine hours × $25 = $12,500
What is the cost of Job 100 under normal costing?
Direct materials
45,000
Direct labor
14,000
Factory overhead
12,500
Total
$71,500
12
Transactions
Purchase of materials and other manufacturing inputs
Conversion into work in process inventory
Conversion into finished goods inventory
Sale of finished goods
13
Procurement of Materials
$80,000 worth of materials (direct and
indirect) were purchased on credit.
Materials
Control
80,000
Accounts Payable
Control
80,000
14
Materials to Work in Process
When materials go to the production space they add to
“Work in Process”
Materials costing $75,000 were sent to the
manufacturing plant floor.
$50,000 were issued to Job No. 650 and
$10,000 to Job 651.
$15,000 of indirect materials were issued.
What is the journal entry?
Work in Process Control:
Job No. 650
Job No. 651
Factory Overhead Control
Materials Control
50,000
10,000
15,000
75,000
15
T – Account Representation
Materials
Control
80,000 75,000
Manufacturing
Overhead
Control
15,000
Work in Process
Control
60,000
Job 650
50,000
16
Accounting for Wage Cost
Total manufacturing payroll for the period was $27,000.
Job No. 650 incurred direct labor costs of $19,000 and
Job No. 651 incurred direct labor costs of $3,000.
$5,000 of indirect labor was also incurred.
What is the journal entry?
Work in Process Control:
Job No. 650
Job No. 651
Manufacturing Overhead Control
Wages Payable
19,000
3,000
5,000
27,000
17
T – Account Representation
Wages Payable
Control
27,000
Manufacturing
Overhead
Control
15,000
5,000
Work in Process
Control
60,000
22,000
Job 650
50,000
19,000
18
Manufacturing Overhead Costs
Assume that depreciation for the period is $26,000.
Other manufacturing overhead incurred amounted to
$19,100.
What is the journal entry?
Manufacturing Overhead Control
Accumulated Depreciation Control
Various Accounts
45,100
26,000
19,100
What is the balance of the Manufacturing Overhead
Control account?
19
T- Account Representation
$62,000 of overhead was allocated to the various
jobs of which $12,500 went to Job 650.
Work in Process Control
62,000
Manufacturing Overhead Control
62,000
What are the balances of the control accounts?
20
Manufacturing Overhead Work in Process
Control
Control
15,000 62,000
60,000
5,000
22,000
45,100
62,000
Bal. 3,100
Bal. 144,000
Job 650
50,000
19,000
12,500
Bal. 81,500
21
Work in Process to Finished Goods
Jobs costing $104,000 were completed and
transferred to finished goods, including Job 650.
What effect does this have on the control accounts?
Work in Process
Control
60,000 104,000
22,000
62,000
Bal. 40,000
Finished Goods
Control
104,000
22
Sale
Job 650 was sold for $114,800.
What is the journal entry?
Accounts Receivable Control 114,800
Revenues
Cost of Goods Sold
81,500
Finished Goods Control
114,800
81,500
23
Marketing & Administrative Costs
What is the balance in the Finished Goods Control
account?
$104,000 – $81,500 = $22,500
Assume that marketing and administrative salaries
were $9,000 and $10,000.
What is the journal entry?
Marketing and Administrative Costs
Salaries Payable Control
19,000
19,000
24
Inventory Accounts and Cost of Goods Sold
+
–
=
Direct Materials Used
Direct Labor and Overhead
Cost of Goods Manufactured
Ending WIP Inventory
$60,000
$84,000
$104,000
$40,000
–
=
Cost of Goods Manufactured
$104,000
Ending Finished Goods Inventory $22,500
Cost of Goods Sold
$81,500
25
Underallocated and Overallocated Costs
Underallocated indirect costs:
The allocated amount of indirect costs is lower than
the actually incurred amount
Overallocated indirect costs:
The allocated amount of indirect costs is higher than
the actually incurred amount
One possibility to balance the accounts: Write-Off to
Cost of Goods-Sold:
Cost of Goods Sold
Manufacturing Overhead Control
3,100
3,100
26
Transactions and Flow of Costs
Materials Ctl
Materials
Procurement
(2)
WIP Ctl Finished Goods Ctl CoGS (6) Income St.
(5)
(4)
Revenue
Wages payable
(2)
Manuf. Overhead
Acc. Receivable
(3)
(6)
Settlement of Receivables
Acc. Deprec.
Selling & Administrative
(6)
Acc. Payable
Cash ; Bank
(7)
(1)
Settlement of
Payables
27
Absorption Costing
Absorption Costing allocates all manufacturing costs
to individual products.
The typical “product” is a specific manufacturing job to
which direct costs are traced.
For each indirect cost pool (“Overhead”) an allocation base
is defined and an “overhead rate” (= amount in the cost pool
/ total units of the allocation base).
• Allocation bases are traceable to products
• Overhead cost (in pool) allocated to the product =
= units of pool-specific allocation base traced to product
× pool-specific overhead rate.
• Common allocation bases are e.g.
direct labor costs
machine hours used for the job
28
Incentive Effect of Absorption Costing
With Absorption Costing “cost averages can even be
calculated for each product as well. Of course, this is
silly, but one can do it. (Some even do.)” (Joel Demski,
Managerial Uses of Accounting Information, ²2008, p. 64).
The IFRS, e.g., require absorption cost-based unit costs for
inventory valuation (see IAS 2,10-18).
Incentive Effects of Absorption Costing
A manager deciding on the production volume may enhance
period income by excessive production to inventory.
• He thus “rescues” the fixed costs from being expensed in the
current period. This may make sense when the production
capacity is scarce, such that the inventory enables additional
sales in the next period or when variable cost is expected to
rise. Inventory, however, is a risky asset. It may become
obsolete or destroyed before it can be utilized. Usually,
therefore, the incentive to build inventory will be unwarranted.
29
Two Major Cost Objects
1
2
Products
Responsibility centers
Overhead costs may go to separate pools according to
responsibility centers for control puposes
• (Cost centers, Profit centers, or other)
Responsibility centers may participate in manufacturing
products or render services for other centers.
Responsibility Centers use to be responsible for one or
more output(s) measured by an allocation base
Later on we will treat the problem of how to determine
allocation rates in the case of cycles or reciprocal services
30
Exercise:
What is the total cost of the stay of patient Fred Adams?
Cowley County Hospital uses a job-costing system for all
patients who have surgery. In March, the pre-operating room
(PRE-OP) and operating room (OR) had budgeted allocation
bases of 4,000 nursing hours and 2,000 nursing hours,
respectively. The budgeted nursing overhead charges for each
department for the month were $168,000 and $132,000,
respectively. The hospital floor for surgery patients had
budgeted overhead costs of $1,200,000 and 15,000 nursing
hours for the month. For patient Fred Adams, actual hours
incurred were eight and four hours, respectively, in the PRE-OP
and OR rooms. He was in the hospital for 4 days (96 hours).
Other costs related to Adams were:
Pre-OP-costs
OR-costs
In-room-costs
Patient medicine
$ 200
$500
$2,400
Direct nursing time
$1,000
$ 2.000
$ 3,000
$ 17 380
31
4-30 Data
Budget 2003
Machining dept.
Manufacturing overhead
(allocation base
Direct manuf. labor cost for finishing)
Direct manuf. labor hours
Machine hours (allocation base for machining)
$ 10,000,000
$
900,000
30,000
200,000
Job 431, 200 units of product
Machining dept.
Direct materials used
Direct manuf. labor cost
Direct manuf. labor hours
Machine hours
$ 14,000
$
600
30
130
Actual amounts, end year 2003
Machining dept.
Manufacturing overhead incurred
Direct manuf. labor costs
Machine hours
$ 11,200,000
$
950,000
220,000
Finishing dept.
$ 8,000,000
$ 4,000,000
160,000
33,000
Finishing dept.
$ 3,000
$ 1,250
50
10
Finishing dept.
$ 7,900,000
$ 4,100,000
32,000
32
4-30 Overview of the job-costing system
INDIRECT
COST
POOL
:
}
}
COST
ALLOCATION
BASE
Machining Department
Manufacturing Overhead
Finishing Department
Manufacturing Overhead
Machine-Hours
in Machining Dept.
Direct Manufacturing
Labor Costs
in Finishing Dept.
}
Indirect Costs
COST OBJECT:
PRODUCT
}
DIRECT
COST
Direct Costs
Direct
Materials
Direct
Manufacturing
Labor
33